How To Eliminate $4.5 Trillion of Debt

Note: It’s dark north of NYC. Only those with generators have lights, heat and the ability to communicate. I counted 27 trees down on my property; the costs to make the damage right will be about $10k. Insurance will not pay a dime. I got off easy.

You’ve seen the pictures by now, big trees hanging on downed wires. What you miss from the pictures is the scope of the devastation; it’s massive. Whatever your estimate for the cost of Sandy, and how long it will take to get back to “normal”, double or triple it. And it’s getting cold. Anyway, allow me a (lengthy) ramble on a somewhat bizarre idea that has been floating around.

Tear Up the Paper

Total global debt is around $200Tn. World GDP is less than $70Tn (300% global debt to global GDP). Advanced economies have a higher percent of total Debt/GDP then developing countries. So the crux of the problem lies with Japan, most of the EU and the USA.

The question of what to do with all this debt has become a topic of discussion of late. The catalyst was (surprisingly) the IMF. Some deep thinkers at the IMF have resurfaced an old idea. Just cancel the debt; make it disappear.FTAlphaville,Ambrose Pritchard, and Zero Hedge have had articles that discussed the IMF paper.

This sounds beautiful. According to the IMF, the mechanism for debt cancellation is already in place. The proposal is to simply eliminate all of the US Treasury debt that is purchased by the Fed (QE). At the end of the day, the citizens “own” both the Treasury and the Fed, so the loss to the Fed from cancellation is the gain of the Treasury. One pocket is full of Assets; the other pocket is full of Debts. Both pockets are emptied; no one is richer or poorer as a result.

Hmmm. What’s wrong with this?

-The Fed would have a loss. Does this matter? I’m not sure. The most important Central Bank in the world would have a negative net worth. But the Fed would still have the Full Faith and Credit of the USA behind it, so the loss is irrelevant.

-If the Fed wanted to tighten monetary conditions at some point in the future it would normally sell the bonds that it had purchased. But if the bonds had been cancelled, the Fed would have nothing to sell, and therefore could not reduce reserves.

Ideas like this scare the crap out of worriers like me. The result of debt cancellation (ala the IMF)is a permanent increase in money outstanding (signorage). But the reality is, the bonds purchased by the Fed ARE permanent. The Fed will never be able to sell the trillion or two of Treasury bonds that it owns, so we might as well just recognize that fact, and cancel the bonds.

-The problem that I see is one of scale. How much additional Treasury debt could the Fed buy and then cancel? They currently have approximately $1Tn that is eligible for cancellation. There is a limit to the purchases that could be accomplished. I don’t think the Fed could buy an additional $3Tn without serious consequence to the government bond market.

-This is a goofy concept. Arbitrarily cancelling publicly issued debt has a bad ring to it. This has the appearance of a desperate act. Destabilizing the Fed might have negative consequences.

The IMF's objective is to reduce debt by a meaningful percentage, and to accomplish that without consequence. If that is the case, I have a an alternative proposal. America could eliminate $4.5Tn of IOUs with the stroke of a pen. Debt to GDP would fall from today’s perilous level of 102%, to a much more comfortable 70%.

That also sounds nice, BUT, I hope to show that there ain’t no free lunch when it comes to tearing up IOUs.

The Plan

The Social Security Trust Fund (SSTF), the Federal Workers Retirement Fund (FERF) and the Military Retirement Fund (MRF) are sitting on a whopping $4.6Tn of Special Issue Treasury Securities. This category of debt is referred to as intergovernmental debt. What would happen if all of this debt was erased? Not a damn thing. That may sound impossible; follow the money.

SSTF, FERF and MERF all have the same operating profile:

-They take in real cash money.

-They pay benefits.

-They have assets in the form of those Special Issue securities.

-They earn interest on their assets. Importantly, interest is not paid in cash, it is paid with more paper.

Consider what happens with SSTF. In 2012 they will have an operating cash shortfall of $50Bn. It must have cash in hand to pay the benefits, so it must sell (redeem) an amount of its portfolio of SI bonds to cover the shortfall. It redeems the necessary amount with the Treasury. The Treasury has no cash lying around so it must issue more Debt to the Public. The result:

Pre-SSTF cash shortfall

Debt to Public = 12.0Tn

IG Debt = 4.5Tn

Total = 16.5Tn

Pro-forma a $100Bn SSTF cash shortfall:

Debt to Public = 12.1Tn

IG debt = 4.4Tn

Total = 16.5Tn

Note that Debt to Public (DTP) increases, IG goes down, total debt is unchanged. Now consider what happens when IG debt is eliminated:

Pre-SSTF cash shortfall

Debt to Public = 12.0Tn

IG debt = 0

Total = 12.0Tn

Pro-forma a $100Bn SSTF cash shortfall:

Debt to Public = 12.1Tn

IG debt = 0

Total = 12.1Tn

So there you have it. It doesn't matter at all if the Intergovernmental Account is eliminated and all those Special Issue Treasuries are ripped up. $4.5Trillion of US debt is just a fiction.

I know that there will be some who look at this and say, "But the bonds held by the SSTF are my security that SS will continue to pay monthly checks". There is not one shred of truth to that line of thinking. Congress can alter the benefits paid by SS anytime it chooses. The existence of the SS Trust Fund has nothing to do with that promise to pay.

When you peel back the onion that is the Intergovernmental Account, you find that there are no real assets, just paper and accounting gimmicks.

If the objective is reduce debt, there are cosmetic ways to do it. But eliminating the debt does not eliminate the underlying problem. As long as the SSTF, FERF and MRF run annual cash deficits (they will for the next 75 years) the real debt that America has, will have to rise.

The result of eliminating the IG debt is not unlike the consequences of the IMF's Chicago Plan. It looks like something is being achieved. The result is an immediate reduction in debt. But really that is just a charade. The liability just pops up someplace else. The pain of debt is not eliminated, just hidden so we feel better about it. Sorry IMF, it won't work.

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Geezus! they cuda dunnit for Arhgentinia and Zimbawhu-hu after their wig-wam prices collapsed!

What this really is, Brucey, is a broke-ass IMF + Legarde suffering from chronic irrelevancy disorder, desperately searching for some contrived purpose to seem quasi-purposeful and appear central to something that actually matters. Rather than just going away in an entropic poof of nothing worth having around.

Why limit this scheme to just $4.5 trillion? Why not just have the Fed buy up all the US government's debt and then extinguish it? In fact, why not just eliminate taxes and fund all state and federal government operations by debt that the Fed would immediately buy up and cancel?

I think that the reason that QE has not created massive inflation is because it is offset by a lot of zero velocity money that is accumulating because the economy is stagnant and possibly also because boomers are saving for retirement. But at some point the economy will recover or the boomers will need their money back to fund their retirements and the Fed will be forced to undo QE in order to avoid inflation. If it has cancelled all the QE assets it has purchased, it has no way to undo QE.

”… .the validity of the public debt of the United States, authorized by law… shall not be questioned”

I think that threatening to create conditions that may cause the US not to pay the debt owed it's own citizen's falls under questioning the validity of that debt. A prior ruling by the Supreme Court albeit on an unrelated issue appears to back this up.

“Whoever willfully injures or commits any depredation against any property of the United States, or of any department or agency thereof, or any property which has been or is being manufactured or constructed for the United States, or any department or agency thereof, or attempts to commit any of the foregoing offenses, shall be punished as follows:

If the damage or attempted damage to such property exceeds the sum of $1,000, by a fine under this title or imprisonment for not more than ten years, or both; if the damage or attempted damage to such property does not exceed the sum of $1,000, by a fine under this title or by imprisonment for not more than one year, or both.”

Furthermore Bruce your a limousine liberal who is always harping on Social Security but you don't say jack shit about REAL WELFARE PROGRAMS that actually cost taxpayers Social Security is entirely self funded unlike Snap, Subsidized Housing, Child Care or PUBLIC PENSIONS. Your answer is always to go after the elderly who paid their own way instead of the vampires who are really sucking the life blood out of America.

But they are averting asking the Treasury for money in the future by an accounting gimmick that will simply dump the debt off the capital part of the balance sheet, so it won't be reported as a loss, and make it a liability to the Treasury. More from Reuters:

[According to]Raymond Stone, managing director at Stone & McCarthy in Princeton, New Jersey, "An accounting methodology change at the central bank will allow the Fed to incur losses, even substantial losses, without eroding its capital."

The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability...

"Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

"The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement (of a second round of asset buys) about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly," Smedley and his colleague Priya Misra wrote in a research note.

Bottom line: We all knew the Fed was going to have to do some kind of monkey business to deal with all the junk securities it purchased, here it is: Negative liabilities. Yes, only at your local Fed.

#1) The fact that it is unquestionably valid public debt doesn't mean it cannot be cancelled.

#2) Bruce has demonstrated via math that the IGO debt is just a bookkeeping entry. It is basically there to keep score of how the program is doing in terms of funding itself, which leads me to...

#3) Social Security is not self-funding. If it was, shortfalls would be impossible. Yet as this post demonstrates, once the cumulative shortfalls consume the total IGO debt, the treasury has to fund the difference. QED the SSTF is not self-funding.

#4) Related to #3, seniors are taking out MORE from the system than they contribute, when you measure the contributions and withdrawals in real terms (i.e. when you account for interest). I'm all for people getting back a reasonable (risk-adjusted) return on an actuarial basis (i.e. adjusting to account for the extra contributions of those who die before receiving benefits) but nobody should be getting a windfall rate of return.

#5) And this really shouldn't be last, because it is so important: A CENTRAL BANK CAN NEVER SUFFER A REAL LOSS. Losses are irrelevant to an entity that prints the currency that its losses are measured in. Adjusting how the Central Bank's capital is measured is a distraction, because whether it has paper losses that it can make up to itself via printing is irrelevant. The real issue here is that the entitlements put an added strain on the Treasury to issue more debt, which hastens the day when the bond vigilantes strike (and please let it be sooner rather than later). In reality, instead of suffering a loss, the Central Bank shifts the loss to anyone holding onto the currency via the cantillon affect.

Social Security’s revenue was about $800 billion in 2010. The program has three sources of income. The largest source comes from workers and employers who contribute 6.2% each on wages up to $106,800 a year; this raises about 80% of the total. The second source is investment income from Social Security’s reserves, which are held in Trust and invested in interest-bearing U.S. treasury bonds; this raises about 15% of total revenue. Finally, Social Security gets about 5% of its revenue from the taxes that beneficiaries pay on their Social Security benefits.

"Here's how it works: For nearly three decades Social Security produced big surpluses, collecting more in taxes than it paid in benefits. The government, however, spent that money on other programs, reducing the amount it had to borrow from the public, including foreign investors. That's why some advocates complain that Congress has "raided" Social Security.In return, the Treasury Department issued special bonds to Social Security. The bonds are now valued at $2.7 trillion."

Number 4 is bullshit too average Boomer's who were not even alive when S.S. was enacted have paid in more then they will recover

"According to a 2011 study by the Urban Institute, a married couple retiring last year after both spouses had worked throughout their lifetimes wound up paying about $598,000 in Social Security taxes. If the man lives to 82 and the woman to 85, they can expect to collect about $556,000 in benefits."

You look at SS like it was an isolated entity. It is not. It is part of the government. If one pocket of the government is full of IOUs from the other pocket, then it is a wash.

I tell you again, the only thing that matters is cash flow. On that basis, SS is running a deficit of $50Bn a year, In a few years that will be $100Bn.It will exceed $1T over the next 8 years. SS is not self funding, and has no real assets.

It will take time for you to recognize this. But it will happen, even for you. Sorry for the bad news.

I'm delusional (I think that's the word you were trying to use) well hey Silver serfer if you think the TBTF and the Fed or the politicians for that matter since they could get rid of the Fed in a heartbeat would allow the power that comes with the printing press to go you should look in the mirror to find out who is really D E L U S I O N A L.

It Is Impossible For The US To Default

With so many economic, political, and social problems facing us today, there is little point in focusing attention on something that is not one. The false fear of which I speak is the chance of US debt default. There is no need to speculate on what that likelihood is, I can give you the exact number:

there is 0% chance that the US will be forced to default on the debt.

We could choose to do so, just as a person trapped in a warehouse full of food could choose to starve, but we could never be forced to. This is not a theory or conjecture, it is cold, hard fact. The reason the US could never be forced to default is that every single bit of the debt is owed in the currency that we and only we can issue: dollars.

Once you understand the details of modern central banking, you are able to step back and see that it truly is a way for the government to use the printing press to pay its bills. FULL ARTICLE by Robert Murphy

The interesting thing about writing-off the debt held by the Fed is that Ron Paul suggested it last year to underscore how ridiculous QE and Twist have been. In the face of Bernanke saying the Fed wasn't monetizing the debt. What is apparent is how much of a buffoon Bernanke and Geithner look right now. Even establishment economists have conceded the point.

It also makes the debt ceiling debate completely meaningless. $8trn of the $16trn outstanding is either intragovernmental or owned by the printing press. And these people need to raise my taxes?

But what's also interesting is that the IMF economists are thinking about this backwards. They think the debt to GDP ratio is causing the crisis. So their thought is to just eliminate portions of the debt and the metric improves. In other words, they're saying the US has unused free lunch ticket waiting to be cashed. Fundamentally missing the real point: the cash flows for the US government are deteriorating.

The mainstream discussions about the debt are all meant to throw people off the scent. In the end, UST are used as collateral to lever off of and the Fed will forever and always make sure that they are liquid. As Geithner said "monetize everything" and that's exactly way they will end up doing when pressed.

I'll see your bet and raise you. The end game is to nationalize all 401K and other private retirement accounts and transfer them to SSI. Once they are in SSI you buy up all debt and extinguish it. Then the government has no debt and can pay out whatever it thinks is an appropriate retirement amount.

"nationalize all 401K and other private retirement accounts and transfer them to SSI"

This is hard to do, unless TPTB can convince the middle class the Gov't entitlements are a better deal. Perhaps if the S&P Falls below 600, but currently the gov't is doing everything to keep the market going up. At this time it seems that gov't is more interested in printing than consificating money. Your plan is only viable if they pull an 180 and engage austerty and deflation.

This is very workable. What it means is that the FED is directly monetizing the debt, rather than indirectly, and the fed.gov would never have to issue debt again - just get Ben to print up their spending. It is essentially what is happening anyway.

"If the Fed wanted to tighten monetary conditions at some point in the future it would normally sell the bonds that it had purchased. But if the bonds had been cancelled, the Fed would have nothing to sell, and therefore could not reduce reserves."

Forget QE Infinity...THIS is the way you convince the markets you're serious about reflation. Akin to tossing your parachute overboard as you take off...you're committed, with no turning back.

What you are suggesting has already been occurring with the cash deficits in the SS trust fund since 2010. When the SS trust fund interest is redeemed, additional debt held by the public is issued, due to the budget deficit. (If a budget surplus, general revenues would be used to redeem the interest, an immediate budget, cash expense).

While intragovernmental debt goes down due to the redemption, debt held by the public increases by the same amount, thus leaving total debt the same.

If this was done on a grander scale, with the $4.5 trillion, the same process would occur - total debt would stay the same, while wiping out intragovernmental debt.

This is the problem I have with intragovernmental debt. The asset part was used immediately by the Treasury over the years to pay real expenses and lower real deficits. The liabiity part did not materialize until the cash flow shortfall in 2010 necessitated the redemption of Treasury interest, 27 years after the trust fund surplus started to grow. All of this is occurring without any impact on the budget, from a cash perspective. Even the redemption of interest in 2010, 2011, and 2012 did not result in a budget, cash expense, due to the issuance of additional debt held by the public. Deficits are lowered through the use of trust fund interest and principal, interest in the trust fund is accrued, and no where has the liability part affected the budget and cash flow.

The asset part of the debt has been used immediately and continuously for 29 years, while the liability part, from a cash perspective, has been deferred.

The result: debt in which the asset part is used immediately and continuously and the liability part is irrelevant, from a cash, budget, expense perspective.

Whose debt are you going to cancel? Just Federal? What about Muni Debt. OK, then Fed and Muni? Where do you draw the line? What happens when people stop paying off their debt because they feel they are entitled to a Jubilee too?

What happens after all of the debt is canceled and the gov't needs to borrow again (the next day)? Who is going to buy US gov't bonds when they can just cancel them? Does the Fed just buy all future Gov't debt? Then what prevents the gov't from just running Budget deficits of $10 Trillion per year?

I only seen a few trees upturned on TV, but i noticed something telling with every one of them, namely that they were all very poorly rooted for the size of tree. Its as if they were planted as adults, that or the top-soil sits aloft concrete. One in particular was a beast of a tree, possibly 80years or older, but it just blew over like a matchstick...the little wooden house beside it was left standing though. The house should of went; the tree had it been properly planted should have resisted 70mph winds and went on for another few hundred years.

The tree may not have had deep roots due to there being plenty available water near the surface (or too much water deeper down), and/or having never been subjected to strong winds.

A forest is usually pretty strong; once you create an opening, the taller trees in the middle that have been protected from winds their whole lives suddenly get exposed to direct gusts and start falling over.

Cancel the debt to what end? Do you believe they would learn something from the experience and start doing the right thing? They wouldn't, you know. It would only encourage them to double their efforts at pushing the envelope. If $4.5 trillion can be forgiven, why not $9 trillion...then $18 trillion?

Everyone is looking for easy and painless resolutions to this mess. There aren't any. JMO.

I have a real problem with this Bruce, from the average debter standpoint. Government can just welsh on it's debt, but a small fry that does it goes to hell? You want to destabilize the "full faith and credit" of the US Government, start cancelling it's debt while telling the average joe that he still has to pay his HELOC off. Not only will that tick off the 99 percenters, a large percentage of them have guns and are just waiting for a triggering moment to set them off.

Government welshing on debt, magical or no, would IMO, be such a moment.

Shatter the faith in the dollar and suddenly that piece of paper is just pretty TP. Monopoly money. Get the majority of folks not wanting to take it in exchange for services or items rendered and we fall messily back on to barter and other "hard" items.

Not to say that the dollar is worth much anyway. (at least the paper, the copper pennies are worth twice their face value.) Minimum wage is a joke with prices where they are, the middle class has lost 50% of it's purchasing power in the past 50 years and we now have a debt more than our entire economy is able to produce in a year and much of what we produce is service oriented.

You don't include the masses in your debt forgiveness and you can kiss your government behind goodbye

And if the USA, EU and Japan said "Hey....we're gonna cancel our debts." What would the average Joe think of this ? And how would the courts rule if average Joe said to BOA.."Cancel my Mortgage because the Fed cancelled the bond you're holding which included my mortgage." This is lunacy. It would destroy the fabric of society.

Ditto. Some people here are thinking rationally. Economics is psycology, and from a psycological standpoint, there is no real effective difference between cancelling trillions in debt or printing trillions to pay off the debt. What will governments of the world do after cancelling trillions in debt that "they owe to themsleves" (and possibly other type of debt instruments)? They will go on a spending binge like never before seen in human history, spending trillions more to support a parasitic statist societal structure. After all if we can cancel it without any serious ramifications, why not start another trillion dollar war? The FED prints, buys the treasuries, and then we just cancel it later right? Why not give out "high quality" food stamps for disadvantaged people so they can eat at Per Se, like the one percenters? The FED prints, buys the treasuries, everyone spends trillions eating haute cuisine, and we just cancel the debt later. What could possibly go wrong with that?

Why is it that when you and others talk about Social Security, you seem to leave out the fact that we all paid the money into Social Security and instead of it staying in the SS fund, the congress took the money and spent it on other things? The intimation always seems to be that SS is broke and is not taking in enough money to pay for itself. In the now, this is true of course, but over the life of the system, SS should have mucho dinero saved up and could be funded for many years to come. The boomers could get their SS payments if congress just gave back what they stole.

Congress stole the SS funds. No big revelation there, but most people do not understand this. I think you should make it clear in every article you write on the subject. I don't know about the other funds you mention, but I imagine it's the same.

Actually you're mistaken. At the beginning of the program, the people making withdrawals obviously hadn't made any contributions yet. If you were old enough to collect benefits when the program first started, you got a windfall. Even now-a-days, what people contributed is worth less, in real terms, compared to what they take out (if they live long enough). Remember, when the program started, people were not expected to live this long. The entire thing needs to be actuarially adjusted so it balances.

You are correct that there are still $4.6T of contributions that have been accumulated by the program over time, and boomers could be paid out. But guess what, the world doesn't stop once the Boomers get paid. What about all of us now who are contributing who know we won't see a dime back? Why should we continue contributing so boomers can get their windfall payments?

And don't say we stole the money from ourselves. My whole life, every person I ever talked to about SS who knew what was happening was against what congress did. Congress took the money to pay for other programs, mostly to buy votes.

Congress stole the money because they could. The original iintention of the act was never to be what has occurred. Unfortunately you can only prevent congress from doing something if you specifically deny them the right to do it, such as the 1st and 2nd amendment, and we all see how hard they have tried to get around that.

Transformer - of course we did it...whether through omission or allowing ourselves to be bribed for pennies while dollars were stolen by others...we all knew but we as a nation weren't willing to get our hands dirty and demand better. Democracy is what ever shit we say it is. The coutcome is on us...not some thing done to us. We aren't victims - we're part of the fucking problem...but that also should infer we can be part of the solution.

What you say is true. But what you leave out of your responsibility equation is gov corruption. I don't know but I would imagine that taking funds from the SSTF could be decided by some court to be illegal, as it breaks the intent of the Bill. People thought we had a good system of government with laws that prevent corruption. And this was true to a large extent. And so people didn't watch the process, the people were concerned with other things. Criminals began the corruption process and were simply not prosecuted. This has continued to the point of where we are today, that no elite goes to jail for any crime, no matter how heinous, ever.

I would submit to you that our system was criminally corrupted and our system of regulation, and criminal prosecution is at fault.

If you have a nice house, with nice possessions, and a thief comes on a night when you are gone and steals everything, whose fault is that? Furthermore, suppose you know who the thief is, with incontrovertible proof, and the authorities will do nothing about it. Whose fault is that? Should the victim have elected a more honest police chief? But the police chief is on the payroll of the thieves. How did such a man get in that position?

Now you can blame it on all of us, but that doesn't solve anything. There are members of society with much greater culpability than you and I. We all need to shout out, and the media too, who these criminals are and do something about them. If Ron Paul had not been cheated out of his early primary wins, he would likely be the candidate today, and all those criminals would be quaking in their boots. The time is coming, and it may be after the collapse, when retribution will occurr. If America is a third world nation by then, it probably won't matter much.